Investment fundamentals: Gross domesticproduct

Gross domestic product (GDP) is the market value of all goods and services produced within a nation. GDP represents the size of a nation’s economy and is used to determine the economic growth rate (or GDP growth). GDP is widely used to gauge a country’s economic health and standing relative to the rest of the world.

GDP encompasses the following factors: personal consumption, business investment (purchases made by companies to produce consumer goods); government spending, and net exports of goods and services (exports minus imports).

GDP growth naturally moves in cycles.

Fluctuations in GDP is normal as economies alternate between periods of growth and decline. Accelerating GDP growth generally indicates increased employment, consumption, and investment. GDP growth generally boosts economic confidence, which, in turn has been known to influence companies’ investing, hiring, consumption and wage-setting decisions.

Conversely, GDP contraction suggests easing in these economic indicators. Two consecutive periods of declining GDP is widely considered a sign of economic recession.

GDP can signal certain economic trends that may impact capital markets.

Investors monitor a country’s GDP in order to identify economic developments that may affect their asset-allocation decisions. Comparing GDP growth across nations and time periods may also help inform investment decisions. Expanding GDP typically correlates with stronger-performing markets. When GDP growth accelerates, therefore, investors tend to favor riskier assets, which are expected to provide higher returns in stronger markets. Strong GDP growth may also point to greater demand for credit among businesses and consumers alike—and increased borrowing usually coincides with higher interest rates, which may signal rising inflation.

On the other hand, when GDP growth weakens, investors are typically more risk-averse and flock to so-called safe-haven assets such as higher-quality equities, gold, and government bonds.

Although a widely used metric of economic health, GDP does not include some important components of a nation’s economy.

The formula used to calculate GDP excludes factors such as child care, unpaid services and volunteer work, as well as so-called black-market activities (which, while illegal, impact economic growth). GDP calculations also omit external costs tied to certain goods and services, such as the disposing of materials that are otherwise inexpensive to create. GDP per capita (total GDP divided by total population), which is used to measure a nation’s standard of living, does not consider income inequality among citizens.

Important information

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice and is intended for educational purposes only. There are risks involved with investing, including loss of principal. Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company. Neither SEI nor its subsidiaries is affiliated with your financial advisor.